Becoming A FINRA Member Firm: Understanding The New Membership Application Process

The Financial Industry Regulatory Authority (FINRA) plays a central role in the oversight of broker-dealers operating within the U.S. As part of its mandate to ensure market integrity and protect investors, FINRA administers a rigorous new member application (NMA), which is reviewed by FINRA’s Membership Application Program (MAP) group. The NMA is designed to vet potential entrants to the securities industry, ensuring they meet stringent standards of financial stability, operational capability and ethical conduct. Prospective applicants must go through a thorough assessment that involves providing detailed documents for the NMA, such as comprehensive background checks, financial records, robust policies and procedures and a careful examination of the business plan. ¹ Further, FINRA evaluates the applicant's management to ensure they have the necessary supervisory experience, pass qualifying exams, fulfill continuing education requirements and disclose relevant information on Form U4.

Understanding this process is crucial for firms aiming to establish themselves in the competitive and ever-evolving landscape of U.S. financial markets, where regulatory compliance and robust operational practices are paramount. According to Jennifer Connors, Co-Head of Broker-Dealer Regulation and Compliance at Holland and Knight, “The FINRA NMA process is by far the most daunting aspect of forming a new broker-dealer. This application, along with registration with the SEC on Form BD and licensing of individuals, is accomplished through a detailed electronic submission process, so applicants will need to enroll to access the electronic system known as the Central Registration Depository (CRD). It can be helpful to partner with consultants and legal advisors who know how to navigate the NMA process.”

This article delves into specific steps and requirements involved in becoming a FINRA member, shedding light on the critical components of the NMA process and potential consequences of acting as an unregistered broker-dealer.

In the U.S., any individual or firm engaged in the business of buying or selling securities on behalf of customers, or for their own account (with some exceptions), must be registered as a broker-dealer with FINRA. This requirement encompasses a wide range of entities, including investment banks, securities firms, placement agents and independent brokers. The registration requirement ensures that these entities adhere to strict regulatory standards, designed to maintain market integrity and protect investors. Furthermore, registration with FINRA is mandatory for firms that trade securities on behalf of their customers, their own account or both, or that operate as market makers or placement agents, ensuring they operate within the legal framework established by the SEC. FINRA also regulates capital acquisition brokers (CABs) and funding portals. A CAB is a broker-dealer subject to a narrower set of rules due to a limited scope of activities, while a funding portal is a crowdfunding intermediary and is subject to the SEC's Regulation Crowdfunding and FINRA's corresponding Funding Portal Rules.

In 2023, FINRA approved 109 new broker-dealers. The expected length of time for the NMA process is between six and nine months; however, in some cases it may take longer based on the complexity of the proposed business model. At the end of 2022 there were 3,378 FINRA registered firms, and 620,882 FINRA registered representatives.²

Unregistered Broker-Dealer Activity and Its Consequences

The SEC regularly focuses on unregistered broker-dealer activity in its enforcement priorities. For example, in September 2023, the SEC charged an investment adviser for acting as an unregistered broker. According to the SEC Order, the adviser regularly received transaction-based compensation for brokerage services in securities transactions with its advisory clients.³

And in November 2022, the SEC charged two individuals—as well as the two New York-based entities they controlled—with operating as unregistered broker-dealers that facilitated more than $1.2 billion of securities trading.⁴

Attorneys in the Dechert LLP Financial Services Group point out that “the consequences of failing to register as a broker-dealer can be fatal to a business and to any issuer whose securities are sold by such business and include a bar from the securities business for both the business and its principals and employees as well as rescission of any contracts for the sale of an issuer’s securities that are bought or sold by such an unregistered broker-dealer. Moreover, this has been a renewed area of focus for the SEC as evidenced by recent litigation and enforcement against unregistered crypto firms and investment advisers selling fund interests, as well as in recent rulemakings expanding the universe of firms that are required to register. In addition, because the registration process has a long lead time, and material changes to the business are subject to FINRA approval, ensuring that the broker-dealer's application seeks the appropriate permissions to conduct the desired business is critical to the success of a new firm.”⁵

Section 3a4-1 of the Exchange Act provides a “non-exclusive safe-harbor” that allows issuer's associated persons who conduct limited securities sales for the issuer to avoid being classified as “brokers” under Exchange Act Section 3(a)(4) and avoid having to register under Exchange Act Section 15. Whether this exemption applies depends on the facts of each case and involves issues related to the associated person’s disciplinary history, type of compensation received (no compensation based on transactions or success) and the timing and limited scope of the offering.⁶

Given the serious potential consequences of acting as an unregistered broker-dealer, it is important that you determine whether you or your firm are engaging in, or plan to start engaging in, any broker-dealer activities. And, if necessary, ensure that you are in compliance with the broker-dealer registration requirements of the Exchange Act.

To help with this analysis, in this article we will examine:

• The SEC broker-dealer registration laws, rules and requirements
• The analysis of the application of these requirements to your business activities
• The process of obtaining SEC broker-dealer registration and FINRA membership, including the preparation and filing of Form BD with the SEC and FINRA Form NMA

U.S. Broker-Dealer Registration Requirements

Section 15 of the Exchange Act of 1934 (Exchange Act) requires that any person or entity that is engaging in broker-dealer activities within the U.S. must be registered with the SEC and be a member of a self-regulatory organization (SRO), such as FINRA. The key to compliance with this broad requirement is to understand what makes you a broker-dealer under this rule and what kinds of activities are considered by the SEC to be activities of a broker-dealer (which require registration).

Section 3(4) of the Exchange Act defines "broker" broadly as any person engaged in the business of effecting transactions in securities for the account of others. The term "person" includes entities as well as individuals. As the SEC has acknowledged, a person who executes transactions for others on a securities exchange clearly is a broker.

Unlike a broker who acts as an agent, however, a “dealer” is defined in Section 3(a)(5)(A) of the Exchange Act generally as any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise.⁷  Some examples of individuals or firms which would clearly be considered to be a “dealer” requiring SEC registration would include:

• A firm that advertises publicly that it makes a market in securities
• A person who advertises their services to include regular broker-dealer services or advises counter-parties and prospective customers (verbally or in writing), that they provide customary broker-dealer services.
• A person who runs a matched book of repurchase agreements
• A person who issues or originates securities that they also buy and sell

Of course, this is not a comprehensive list, and you will need to carefully analyze your business activities to determine whether you would be considered to be a dealer requiring SEC registration.⁸  Such analysis would involve considering all aspects of your securities-related business operations, which include (but are not limited to) the following questions:

• Do you advertise, or otherwise let others know, that you are in the business of buying and selling securities?
• Do you do business with the public (either retail or institutional)?
• Do you make a market in, or quote prices for, both the purchase and sale of one or more securities?
• Do you participate in a "selling group" or otherwise underwrite securities?

Practical Impact of SEC Broker-Dealer Registration

SEC registered brokers and dealers are required to comply with all applicable federal securities laws, rules and regulations, including applicable SEC, SRO and U.S. Treasury rules (in the case of registered government securities dealers) and requirements applicable to, among other things:

• Financial responsibility
• Net capital requirements
• Client protection
• Record keeping and reporting
• Regulatory reporting
• Supervision and compliance oversight
• Continuing education and training
• SEC, SRO and U.S. Treasury (in the case of registered government securities dealers) examinations and enforcement

The SEC Registration and FINRA Membership Process

Once you have determined that broker and/or dealer SEC registration is required, you will need to secure registration approval from the SEC by filing your Form BD to be approved as a FINRA Member Firm after submission of your completed FINRA Form NMA and comply with all applicable state-specific requirements. This process must be completed before you can start engaging in any broker-dealer activities which require SEC registration. FINRA is required to render a decision on the NMA within 180 days after FINRA deems your submitted application to be “substantially complete.” There is substantial work to be done prior to submitting your NMA to FINRA and once FINRA approval is received any state specific registration requirements must be met. 

The completed Form NMA is used by FINRA’s MAP group to assess whether an applicant meets the standards for becoming a FINRA-registered broker-dealer. The form contains 12 sections, modeled after the first 12 standards of FINRA Rule 1014 (Form NMA does not elicit specific information regarding standards 13 and 14 Rule 1014). These standards ensure that all aspects of the membership application are accurate and complete, including forms, policies and procedures and agreements. Additionally, the applicant and its associated persons must hold all necessary licenses and registrations from state, federal and self-regulatory authorities. Demonstrating financial responsibility and meeting net capital obligations are also critical components of the admission process. These standards along with others play a crucial role in evaluating an applicant’s suitability for FINRA membership.

Overall, it is important to understand that broker-dealer registration involves a significant commitment. Per Ms. Connors, “Applicants should remember that submitting the NMA takes a great deal of work and preparation, but it is likely not the end of the submissions that a prospective broker-dealer will need to make to FINRA. Typically, FINRA sends a written follow-up request for more information, to which the firm will then have 60 days for the initial response and 30 days thereafter to respond. This may happen several times during FINRA’s review and can extend the approval timeline significantly.”

Development of Operating Model and Compliance Framework

The first step will be to design an efficient operating model which is aligned with strategic goals for your business, considering processes, technology and governance, followed by the development of a compliance framework that consists of policies, procedures and controls that will play pivotal role in navigating regulations and mitigating risks while conducting your business activities. Your compliance program will need to address federal securities laws, as well as SEC and FINRA rules and regulations. It must also address the risks identified based on your operating model. Your operating model will provide FINRA with an overview of your business model and how you will satisfy all 14 standards of admission contained in the NMA.

NMA Filing Overview

Below, is an overview of the sequential actions required when navigating the FINRA NMA process.

• Reserve Your Firm’s Name
  Request and reserve a proposed name for your firm before making any other submissions to FINRA. The name must meet specific requirements. Complete the Firm Name Reservation Form and send it by fax or email to the provided contact details.
• Sign Up For System Access
  Designate a Super Account Administrator (SAA) responsible for creating and maintaining firm account administrator and user accounts for FINRA applications. Once FINRA processes the SAA form, the SAA will receive login credentials, the organization ID number and entitlement to the FINRA systems, required for filings and funding.
• Pay Your Application Fees
  Pre-fund your Flex-Funding Account to pay the appropriate membership fee before submitting a New Member Application (NMA) to FINRA. Determine the required membership fee and submit the initial payment through automated clearing house (ACH) or wire/ACH transfer.
• Meet FINRA’s Standards Of Admission
  Review your business plan to ensure it complies with the standards for admission outlined in FINRA Rule 1014.
• Submit Form BD Online
  The SEC’s Form BD and other registration filings must be submitted and stored as part of the CRD program. Some information collected in this filing is disseminated to the public via FINRA’s investor protection tool, BrokerCheck.

You must prepare your Form NMA to demonstrate compliance with each of these standards. In addressing these standards, certain considerations are of specific importance as they will be of primary focus to FINRA throughout the application process:

• Registered Principals
  New membership applicants (excluding sole proprietorships), must have at least two registered principals. In addition, the applicant must have a financial and operations principal. These registered principals play a crucial role in overseeing and managing the firm’s operations, compliance and supervision, ensuring adherence to industry regulations during the membership application process.
• Supervisory Structure
  As an applicant you must evaluate your registered principals’ qualifications and experience to establish a governance structure. Your proposed supervisory and organizational structure must comply with FINRA Rule 3110 - Supervision.
• Ownership Structure
  As part of your application, you must provide ownership information for the applicant, including: (i) the names of all the applicant’s direct and indirect owners, regardless of the ownership interest that may be held (ii) specific ownership percentages for all direct and indirect owner(s) and (iii) all formation and governing documents for the applicant and its direct and indirect owners. In addition, you must furnish a comprehensive description of the business activities undertaken by each entity listed in the ownership chart.
• Funding And Minimum Net Capital Requirement
  An applicant must meet the provisions of SEA Rules 15c3-1 and 17a-11, the SEC’s net capital rule and early warning rule, respectively, two of several financial responsibility rules of the SEC. Depending on the proposed business activities and operating model of the applicant, the applicable minimum net capital requirement can range from $5,000 to more than $1 million. Overall, the applicant must provide evidence of financial wherewithal to sustain the applicant for the first 12 months of operations, where financial wherewithal is, at a minimum, calculated as the first 12 months of fixed expenses plus 120% of the applicant’s minimum net capital requirement. Such evidence would include complete copies of the three most recent monthly bank statements that have or will be utilized to fund the applicant. The applicant must provide a detailed description of the source(s) funds to be used for the capitalization of the applicant, as well as evidence of the source of funds.
• Online Platforms
  If the applicant operates a communication platform, the applicant is expected to present a demonstration of the functionality of the platform, as part of the application review process. For the initial NMA filing to be deemed substantially complete, the applicant must confirm it is operationally ready for a demonstration at the time of filing.

After the NMA is Submitted

Once an NMA is submitted, FINRA’s MAP group staff will assess the application to determine if it is substantially complete. If the application is found to be substantially incomplete, the applicant will be given five days to correct the deficiency. When a filing is considered substantially complete, FINRA staff has 30 days to conduct a preliminary review. If additional information is necessary, they will issue a written request within that timeframe. The applicant then has 60 calendar days to provide a full response to FINRA’s initial request. This process can repeat as often as FINRA staff determines that it requires new or additional information. Occasionally, applicants may need to amend Form BD and/or the relevant supporting documentation after filing their initial membership application. It is important to note that throughout the NMA process, all information in Form BD and the membership application must be kept current.

All new member applicants are required to participate in a membership interview conducted by FINRA staff. Membership interviews provide an opportunity for applicants to demonstrate how they meet the standards for admission to operate a prospective member firm. Other topics that may be discussed include the firm’s supervisory structure, rules applicable to the business, experience of the firm’s principals and plans for future expansion.

FINRA Decision Letter and Membership Agreement

FINRA will review the NMA including all other information and documents provided by the applicant along with the membership interview, the public interest and the protection of investors, and will send the applicant a written decision letter on the application. The decision letter will state whether the application is approved, approved with restrictions or denied, based upon whether the applicant meets the standards for admission to membership contained in FINRA Rule 1014. If FINRA decides to approve the application subject to restrictions or to deny the application, it will include the rationale for the restriction(s) or denial based on the standards for admission in Rule 1014. Pursuant to FINRA Rule 1014, a decision on a membership application must be issued within 30 days after the conclusion of the membership interview or after the filing of additional information or documents, whichever is later.

Membership approvals or approvals with restrictions are accompanied by a membership agreement to be executed by the applicant at the conclusion of the application process, so that there is a clear understanding of the full scope of the approval of the applicant's proposed business. FINRA membership approval is contingent upon the applicant's returning an executed membership agreement to FINRA. Per Ms. Connors, “Firms need to be mindful of any limitations imposed, such as the number of registered and/or associated persons, net capital requirements or permitted lines of business. In the future, if the firm wishes to, among other activities, enter a new line of business, acquire assets from another broker-dealer and/or if the firm becomes subject to a direct or indirect change of control, the firm will need to go through this process again in the Continuing Membership Application (CMA). FINRA Rule 1017 contains the full list of triggers for a CMA filing, and firms should note that this process is also significant and time-consuming, requiring similar information to that which is submitted in an NMA. This is because FINRA views certain changes and/or events to be so significant to a broker-dealer that the member firm must provide FINRA with information to help FINRA determine whether it may continue as a FINRA member as a result of the changes.”

The membership agreement contains the key terms governing the applicant's admission to membership including, but not limited to:

• Terms of the contract between the applicant and FINRA 
• Approved business activities
• Minimum net capital requirement and associated exemption(s)
• Number of offices permitted to be maintained
• Number of Associated Persons permitted to be employed
• Certifications of the applicant complying with various securities rules and regulations, as well as maintain high standards of commercial honor and just and equitable principles of trade
• Restrictions, if any, FINRA has imposed on the applicant
• Notifications that the applicant is required to make when changes occur with respect to the firm's ownership, control or business operations, pursuant to FINRA Rule 1017

State Registrations

State registrations play a crucial role for both broker-dealer firms and individual registered representatives within the financial industry. Broker-dealers must register in each state where they conduct business and ensure their agents are licensed unless exempted by state law. While most states allow registration through the CRD, some, like Alabama, California, Hawaii, Michigan and West Virginia, require additional direct filings with the state.⁹

While the National Securities Markets Improvement Act preempted certain state laws related to individual securities registration, states still maintain significant authority to impose licensing and qualification requirements on those involved in selling securities. Per Ms. Connors, “The specific state registration requirements depend on factors such as the business model, geographic reach and client types served. For instance, some states exclude firms and their representatives from registration if they exclusively serve “institutional customers” rather than retail clients. Further, it’s essential to recognize that definitions, such as what constitutes an “institutional” entity, can vary from state to state. Additionally, as part of the NMA and state registration process, some states mandate affidavits confirming ‘no prior securities sales,’ emphasizing the importance of compliance before registration.

In summary, broker-dealers must navigate both federal and state registration requirements to operate legally within the securities industry therefore it’s essential to recognize that state laws vary significantly, and careful examination is necessary to navigate these differences.

Conclusion

The process of becoming a FINRA member is a complex and lengthy journey that demands meticulous analysis and preparation. The FINRA NMA process serves as a gatekeeper, ensuring that prospective broker-dealers adhere to stringent standards of financial stability, operational capability and ethical conduct. Acting as an unregistered broker-dealer can have severe consequences, underscoring the need for firms to assess their engagement in broker-dealer activities and, if necessary, ensure compliance with the broker-dealer registration requirements outlined in the Exchange Act. Additionally, maintaining a robust compliance program is essential—it not only facilitates successful NMA completion but also fosters a culture of integrity, minimizes risks and ensures adherence to regulations within an ever-evolving regulatory landscape. Partnering with knowledgeable consultants and legal advisors who understand how to navigate the NMA process can be invaluable.

Kroll compliance consulting experts provide tailored services to assist broker-dealers in meeting regulatory requirements, enhancing compliance programs and navigating the complexities of FINRA rules.
Contact our experts today to learn more.

Sources

¹ Prospective applicants should carefully review FINRA Rule1013. New member application and interview | FINRA.org. (n.d.). https://www.finra.org/rules-guidance/rulebooks/finra-rules/1013
² THE FINANCIAL INDUSTRY REGULATORY AUTHORITY. (2023). 2023 FINRA Industry Snapshot. https://www.finra.org/sites/default/files/2023-04/2023-industry-snapshot.pdf
³ SEC.gov | Investment Adviser Charged for Acting as an Unregistered Broker. (2023b, September 12). https://www.sec.gov/enforce/34-98354-s
⁴ SEC.gov | SEC charges unregistered brokers that facilitated more than $1.2 billion in primarily penny stock trades. (2022, November 17). https://www.sec.gov/news/press-release/2022-207
⁵ “Dechert LLP, Financial Services Group, Neel Maitra, Partner, Derek Manners, Associate, Jennifer O’Brien, Associate, and Elliott Curzon, Senior Counsel.”
⁶The SEC’s 2014 M&A Brokers No-Action Letter (now repealed) had allowed M&A Brokers to effect private company M&A transactions involving a change in control without involving any public distribution of securities, without registering as a broker-dealer so long as the purchaser of the securities would be actively operating the company or its business. This no-action letter was specifically limited to the exact facts relied on by the SEC in the letter and reliance thereon by others in the industry was risky. In December 2022 the U.S. Congress passed a federal exemption for M&A brokers which provided similar relief as the SEC no-action letter, however, introduced specific limitations on what activities the M&A Broker could engage in without registration. Reliance on this exemption from registration requires careful analysis and implementation. In addition, there is SEC no-action relief for certain foreign M&A brokers to, under certain circumstances, contact potential U.S.-based buyers or sellers without registering with the SEC as a broker-dealer.
⁷On February 6, 2024, the Securities and Exchange Commission (“SEC”) adopted new Rules 3a5-44 and 3a44-2 under the Securities Exchange Act of 1934 (“Exchange Act”) (collectively, “Dealer Rules”) which are intended to clarify how “Dealers” and “Government Securities Dealers” are defined under Sections 3(a)(5) and 3(a)(44) of the Exchange Act. The Dealer Rules became effective on April 29, 2024, and market participants who meet the expanded definitions of securities dealer and government securities dealer are expected to comply within one year from the effective date. Given the time it takes to register as a dealer, Kroll recommends that clients expedite their analysis of the Dealer Rules and, if necessary, begin the registration process as soon as practicable.
The Dealer Rules set qualitative standards to determine whether market participants should be subject to these definitions, in part, due to their role in providing liquidity in the market. The Dealer Rules contain very limited exclusions:

• Central Banks, Sovereign Entities, and International Financial Institutions (as defined in the rules).
• Investment Companies registered under the Investment Company Act of 1940; and
• Persons that have or control less than $50 million in total assets.

The Dealer Rules provide that any market participant, other than those specifically excluded, would be deemed a “dealer” or “government securities dealer” for the purposes of Sections 3(a)(5) and 3(a)(44) of the Exchange Act, if it engages in any of the following activities as part of a regular business:

• Regularly expressing trading interest that is at or near the best available prices on both sides of the market for the same security and that is communicated and represented in a way that makes it accessible to other market participants; or
• Earning revenue primarily from capturing bid-ask spreads, by buying at the bid and selling at the offer, or from capturing any incentives offered by trading venues to liquidity-supplying trading interest.

The trading activities highlighted in the Dealer Rules are not an exhaustive list and, in fact, the Dealer Rules may apply to any market participant (including an investment adviser) which engages in a “regular pattern” of buying and selling securities with the effect of providing liquidity to other participants in the U.S. securities markets or the U.S. Treasury market. Our review of the Dealer Rules suggests that firms that may be most affected by the expanded definition are proprietary trading firms, private funds and other investment advisers who engage in proprietary trading.
⁸ SEC guidance states that traders are excluded from the definition of dealer. A trader is someone who buys and sells securities, either individually or in a trustee capacity, but not as part of a regular business. Individuals who buy and sell securities for themselves generally are considered traders and not dealers.
⁹ Heim, R. G. (2019, August 19). Overview of U.S. Securities Laws Applicable to Broker-Dealers. https://www.tarterkrinsky.com/insights/overview-of-u-s-securities-laws-applicable-to-broker-dealers